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Markel Tax

24 Oct 2018

Tax advice: Chargeable event gains on partial surrender and does a director need to file a tax return?

Every year, our tax and VAT helplines receive over 55,000 calls. Each month, we provide a round-up of topical news and below is a summary of the key points our team has been discussing with accountants in October.

Chargeable event gains on partial surrender – something to watch out for

Clients who make partial surrenders on life insurance products face unfair tax charges unless they take action, following the case of Lobler v HMRC.

Instead of fully encashing a policy, a policyholder can make a partial surrender of a policy without giving rise to an immediate income tax charge. However, the income tax charge can only be deferred if the partial surrender does not exceed 5% of the initial investment per policy year (i.e. from the date the policy was taken out to the anniversary of that date). Any partial surrender over this amount is a chargeable event for income tax purposes.

Any gain on a partial surrender is taxed in the tax year in which the ‘policy year’ ends. This is a year from the date on which the policy was taken out. 

The 5% limit applies cumulatively. Therefore, a policyholder who has held a policy for five years could partially surrender up to 25% of the policy without this giving rise to a chargeable event gain.

Partial surrenders of 5% or less are not reportable on the tax return.

Partial surrenders in excess of the 5% limit 

As noted above, where the partial surrender exceeds the 5% limit, a chargeable event gain arises for income tax purposes. This can occur where the individual is unrepresented and can lead to large chargeable event gains where the actual gain was negligible in comparison. This was what occurred in the Lobler case (Lobler v HMRC 2015 STC1893).

Mr Lobler had invested a total of US$1.4m across 100 separate policies. Over the subsequent two years, he withdrew 97.5% of his investment by making partial surrenders on all 100 policies. The result was that, although the actual monetary gain was only around sterling equivalent of $65000, he incurred a tax charge of $560,000 (which is more than eight times the amount of the monetary gain!) under the provisions that apply on partial surrenders of life policies, ITTOIA 205, s507. These provisions treat the entire proceeds of the partial surrenders, less 5% for each year held, as income of the year in which the partial surrenders take place. 

Mr Lobler had been given several options for surrender bur he did not take advice and chose the option that resulted in this disproportionate tax charge. Had he been advised of the charges he would have taken the option that allowed him to make full surrenders of certain policies only. 

He took his case to First Tier Tribunal (FTT) on the basis that there was no tax avoidance motive in what he had done, and the resulting tax bill was disproportionate to the actual gain he had made. The FTT had to reluctantly reject the appeal on the basis that it had no jurisdiction to find against the clear object of the legislation as it stood. 

The case was then taken to Upper Tribunal where he did win, on the grounds that the mistake he made was sufficiently serious to warrant rectification, under the authority of Pitt v Holt [2013] UKSC 26.

HMRC then carried out a consultation on three possible options to change the legislation and avoid a reoccurrence of Lobler. However, instead of changing the existing legislation, they chose to insert a new provision whereby, if the calculation results in a gain which is wholly disproportionate, the policyholder is able to apply to HMRC to have the chargeable event gain recalculated on a just and reasonable basis (ITTOIA 2005 ss507A, 512A).

The application for recalculation should cover all the relevant details, including the economic gain, the premiums paid and the tax due if the chargeable event gain was not recalculated. The legislation provides for HMRC to recalculate the gain and notify the individual, but the individual (or his/her adviser) may suggest an alternative calculation of the gain for the Officer to consider.

The application must be made in writing within four years from the end of the tax year in which the chargeable event gain arose although HMRC has the discretion to extend the deadline. If the chargeable event gain is recalculated and income tax has already been paid on the original gain, HMRC will refund any excess tax paid.

The above provisions do not apply where the chargeable event gain arose as part of an arrangement where the main purpose, or one of the main purposes, is to obtain a tax advantage, even if the tax advantage arises to someone other than the policyholder. 

As the new legislation has retrospective application from 16 November 2017, if you have any clients who have suffered excess tax charges in the past they should consider making an application for the chargeable event gain to be recalculated. For any applications which would be out of time under the deadline above, consider asking HMRC to exercise its discretion (F(No2)A 2017, s9(5)).

There is no statutory right of appeal against HMRC’s recalculation of the chargeable event gain on a just and reasonable basis. Therefore, the taxpayer’s only recourse is by way of judicial review; it is not possible to appeal to the tribunal.

Does a director need to file a tax return?

We are often asked by accountants whether a director of a company needs to file a tax return, where that individual is not already within self-assessment.

Most practitioners would naturally look to the guidance which advises that “you’ll need to send in a tax return, if, in the last tax year….” and it then goes on to list 14 different circumstances. In relation to company directors, the 7th point states: “you were a company director - unless it was for a non-profit organisation (such as a charity) and you did not get any pay or benefits, like a company car”. The guidance on “running a limited company” lists the responsibilities of a director which includes registering for self-assessment and filing a tax return every year.

The problem is that this guidance has no basis whatsoever in legislation; it is merely HMRC’s commentary. There are no provisions in the Taxes Management Act 1970 (“TMA”) nor in the Companies Act 2006 (Part 10) which specifically require a director to file a tax return every year.

There are two main circumstances when a self-assessment return will need to be submitted by a director:

1)    HMRC have issued a notice to file a tax return.

HMRC should be notified by Companies House when a director is appointed and they can then issue a notice to file a tax return to the individual under s8 TMA 1970. Once the notice to file has been issued, a return must be submitted to HMRC, unless the taxpayer has grounds to request that the notice to file should be withdrawn under s8B TMA. The return needs to be submitted even if there is no liability.

2)    The taxpayer has a tax liability (or wishes to claim certain reliefs).

If the taxpayer has an income tax or capital gains tax liability, or needs to pay the high-income child benefit charge for a tax year, and has not already had a notice to file under s8 TMA, then s7 TMA requires them to notify HMRC of their chargeability by 5 October following the end of the tax year. There are some exceptions to this, such as for people whose only income is under PAYE. 

In other words, if the taxpayer has no liability then they do not need a tax return.

If the taxpayer wishes to claim a relief, it is usually possible to do this outside of the tax return (under Sch 1A TMA).

The issue of whether a director has an obligation to complete a return was addressed in the recent First-Tier Tribunal case of Alexander Steele (TC06717). HMRC were unsuccessful in trying to argue that the taxpayer should have been aware of his “obligation” to register for self-assessment as stated in the online guidance. The Judge even commented that the HMRC officer cannot have ever read s7 TMA (because as outlined above, there is no such obligation)!

The conclusion is that if the director has not been issued with a return and does not have an income tax or CGT liability for a particular tax year, there is no need for them to request or submit a tax return.

For further information regarding these topics, please contact us on 0345 223 2727 or email
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